This Quarterly Report on Form 10-Q contains certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements may be identified by words such as "believe," "will," "expect," "project," "may," "could," "anticipate," "estimate," "intend," "plan," "targets" and similar expressions. These statements are based upon our current beliefs and expectations and are subject to significant risks and uncertainties. Actual results may differ materially from those set forth in the forward-looking statements as a result of numerous factors. The following factors, including the factors set forth in Part II, Item 1A of this and previous Quarterly Reports on Form 10-Q and in Part I, Item 1A of the Company's Annual Report on Form 10-K for the year ended
December 31, 2013, among others, could cause actual results to differ materially from the anticipated results or other expectations expressed in our forward-looking statements: ÿ general and local economic conditions;
ÿ changes in interest rates, deposit flows, demand for mortgages and other loans,
real estate values and competition;
ÿ the ability of our customers to make loan payments;
ÿ our ability to continue to control costs and expenses;
ÿ changes in accounting principles, policies or guidelines;
ÿ our success in managing the risks involved in our business;
ÿ inflation, and market and monetary fluctuations;
ÿ the transfer of supervisory and enforcement authority over savings banks to the
Office of the Comptroller of the Currencyand savings and loan holding companies to the Federal Reserve Board;
ÿ the effect of new capital standards to be imposed by banking regulators;
ÿ changes in legislation or regulation, including the implementation of the
Dodd-Frank Act; and
ÿ other economic, competitive, governmental, regulatory and technological factors
affecting our operations, pricing, products and services. Any or all of our forward-looking statements in this Quarterly Report on Form 10-Q and in any other public statements we make may differ from actual outcomes. They can be affected by inaccurate assumptions we might make or known or unknown risks and uncertainties. Consequently, no forward-looking statements can be guaranteed. We undertake no obligation to publicly update any forward looking statement, whether as a result of new information, future events or otherwise. Overview The following discussion and analysis is presented to assist in the understanding and evaluation of our consolidated financial condition and results of operations. It is intended to complement the unaudited consolidated financial statements and notes thereto appearing elsewhere in this Form 10-Q and should be read in conjunction therewith. The detailed discussion focuses on our consolidated financial condition as of
March 27-------------------------------------------------------------------------------- 31, 2014 compared to the financial condition as of December 31, 2013and the consolidated results of operations for the three months ended March 31, 2014and 2013. Our results of operations depend primarily on our net interest income, which is the difference between the interest income we earn on loans and investments and the interest expense we pay on deposits and other interest-bearing liabilities. Net interest income is affected by the relative amounts of interest-earning assets and interest-bearing liabilities and the interest rates we earn or pay on these balances. Our operations are also affected by non-interest income, such as service fees and gains and losses on the sales of securities and loans, our provision for loan losses and non-interest expenses which include salaries and employee benefits, occupancy and equipment costs, professional fees, and other general and administrative expenses. Financial institutions like us, in general, are significantly affected by economic conditions, competition, and the monetary and fiscal policies of the federal government. Lending activities are influenced by the demand for and supply of housing, competition among lenders, interest rate conditions, and funds availability. Our operations and lending are principally concentrated in the Western New Yorkarea, and our operations and earnings are influenced by local economic conditions. Deposit balances and cost of funds are influenced by prevailing market rates on competing investments, customer preferences, and levels of personal income and savings in our primary market area. Certain areas of the Western New Yorkmarket area have recently experienced economic growth especially in Erie County, and the Company has more than doubled its asset size since December 31, 2000. While the recession is officially over and improvements have been noted in the housing market and unemployment rate, this has not yet resulted in strong economic growth. The weakness in economic growth can have a negative effect on a bank's earnings and liquidity. The Federal Reserve is still actively working on keeping interest rates at very low levels. The Fed Funds rate has remained at 0.00%-0.25% for more than five years. The Federal Reserve has indicated that the Fed Funds rate will remain low until its dual mandates of maximum employment and a 2% inflation rate are achieved, and as such, this rate is not expected to increase until mid-2015 or later. Furthermore, at the December 2013meeting of the Federal Open Market Committee ("FOMC"), the Federal Reserve began to taper its quantitative easing ("QE") program by reducing its purchases of mortgage-backed securities and treasury bonds by $10 billionper month, to $75 billion. This program was further reduced by the FOMC at subsequent meetings and current purchases are at $55 billionper month, with additional reductions anticipated in the near future. A tapering of the QE program is expected to decrease bond prices, resulting in higher yields. The expectation of the QE tapering has resulted in recent increases in interest rates offered on mortgage products. Over the past year loan applications have fallen as a result of the higher rates. We will continue to closely monitor the impact of the national and regional economy on our net interest margin, results of operations and critical risk areas, including interest rate risk and credit risk. As discussed in the Company's Annual Report on Form 10-K Part I, Item 1 "Business - Supervision and Regulation" for the year ended December 31, 2013, since October 2008, numerous legislative actions, including the Dodd-Frank Act, have been taken in response to the financial crisis affecting the banking system and financial markets. While we do not know all the possible outcomes from these initiatives, we can anticipate that the Company will need to dedicate more resources to ensure compliance with the new legislation and regulations, which may impact profitability. There can be no assurance as to the actual impact any governmental program will have on the financial markets or our financial condition and results of operations. We remain active in monitoring these developments and supporting the interests of our shareholders.
Our Reputation. Our primary management strategy has been to retain our perceived image as one of the most respected and recognized community banks in
community. Our management strives to accomplish this goal by continuing to emphasize our high quality customer service and financial strength.
Branching. We opened our sixth branch office in
Erie County, New Yorkduring the second quarter of 2013. This branch is located in Snyder, New Yorkand is our eleventh branch overall. This office had generated $5.6 millionof deposits as of March 31, 2014. Our offices are located in Dunkirk, Fredonia, Jamestown, Lakewoodand Westfieldin Chautauqua County, New Yorkand in Depew, East Amherst, Hamburg, Kenmore, Orchard Parkand Snyderin Erie County, New York. Saturation of the market in Chautauqua Countyled to our expansion plan in Erie County, which is a critical component of our future profitability and growth. An important strategic objective is to continue to evaluate and enhance the technology supporting our customer service. We are committed to making investments in technology and we believe that it represents an efficient way to deploy a portion of our capital. To this end, the Company has developed a five year plan for the implementation of cost effective and efficient digital services to meet our customer's technology needs, to focus on attracting new customers, and to improve our operational efficiencies. Although we remain committed to expanding our retail branch footprint whenever it makes strategic sense, we will be concentrating our near term efforts on developing "clicks" instead of "bricks." Our People. A large part of our success is related to customer service and customer satisfaction. Having employees who understand and value our clientele and their business is a key component to our success. We believe that our present staff is one of our competitive strengths, and thus the retention of such persons and our ability to continue to attract quality personnel is a high priority. Residential Mortgage and Other Lending. Historically, our lending portfolio has consisted predominantly of residential one- to four-family mortgage loans. At March 31, 2014and December 31, 2013, we held $169.2 millionand $170.8 millionof residential one- to four-family mortgage loans, respectively, which constituted 61.6% and 61.8% of our total loan portfolio, at such respective dates. We originate commercial real estate loans to finance the purchase of real property, which generally consists of developed real estate. At March 31, 2014and December 31, 2013, our commercial real estate loan portfolio consisted of loans totaling $58.2 millionand $58.7 millionrespectively, or 21.2% and 21.3%, respectively, of total loans. In addition to commercial real estate loans, we also engage in small business commercial lending, including business installment loans, lines of credit, and other commercial loans. At March 31, 2014and December 31, 2013, our commercial business loan portfolio consisted of loans totaling $13.1 millionand $12.6 million, respectively, or 4.8% and 4.6%, respectively, of total loans. Other loan products offered to our customers include home equity lines of credit, construction loans and consumer loans, including automobile loans, overdraft lines of credit and share loans. We may sell one- to four-family residential loans in the future as part of our interest rate risk strategy and asset/liability management, if it is deemed appropriate. We typically retain servicing rights when we sell one- to four-family residential mortgage loans. One- to four-family residential mortgage loans will continue to be the dominant type of loan in our lending portfolio. Investment Strategy. Our investment policy is designed primarily to manage the interest rate sensitivity of our assets and liabilities, to generate a favorable return without incurring undue interest rate and credit risk, to complement our lending activities and to provide and maintain liquidity within established guidelines. We employ a third party financial advisor to assist us in managing our investment portfolio and developing balance sheet strategies. At March 31, 2014and December 31, 2013, we had $155.3 millionand $158.0 million, respectively, invested in securities available for sale, the majority of which are agency mortgage-backed securities, agency collateralized mortgage obligation securities ("CMOs") and municipal securities. Asset-Liability Strategy. As stated above, our business consists primarily of originating one- to four-family residential real estate loans and commercial real estate loans secured by property in our market area and investing in residential mortgage-backed securities, CMOs and municipal securities. Typically, one- to four-family residential real estate loans involve a lower degree of risk and carry a lower yield than commercial real estate and commercial business loans. Our loans are primarily funded by time deposits and core deposits (i.e. 29
-------------------------------------------------------------------------------- checking, savings and money market accounts). This has resulted in our being vulnerable to increases in interest rates, as our interest-bearing liabilities will mature or re-price more quickly than our interest-earning assets in a rising rate environment. Although we plan to continue to originate one- to four-family residential mortgage loans going forward, we have been and intend to continue to increase our focus on the origination of commercial real estate loans and commercial business loans, which generally provide higher returns and have shorter durations than one- to four-family residential real estate loans. Furthermore, our interest rate risk strategy involves improving our funding mix by increasing our core deposits in order to help reduce and control our cost of funds. We value core deposits because they represent longer-term customer relationships as well as lower cost of funds. As part of our strategy to expand our commercial loan portfolio, we expect to attract lower cost core deposits as part of these borrower relationships. We offer competitive rates on a variety of deposit products to meet the needs of our customers and we promote long term deposits, where possible, to meet asset-liability goals. We are actively involved in managing our balance sheet through the direction of our Asset-Liability Committee and the assistance of a third party advisor. Recent economic conditions have underscored the importance of a strong balance sheet. We strive to achieve this through managing our interest rate risk and maintaining strong capital levels, putting aside adequate loan loss reserves and keeping liquid assets on hand. Diversifying our asset mix not only improves net interest margin but also reduces the exposure of our net interest income and earnings to interest rate risk. We will continue to manage our interest rate risk by diversifying the type and maturity of our assets in our loan and investment portfolios and monitoring the maturities in our deposit portfolio and borrowing facilities. Critical Accounting Policies It is management's opinion that accounting estimates covering certain aspects of our business have more significance than others due to the relative importance of those areas to overall performance, or the level of subjectivity required in making such estimates. Management considers the accounting policy relating to the allowance for loan losses to be a critical accounting policy given the uncertainty in evaluating the level of the allowance for loan losses required for probable credit losses and the material effect that such judgments can have on the results of operations. Management's monthly evaluation of the adequacy of the allowance considers our historical loan loss experience, review of specific loans, current economic conditions, and such other factors considered appropriate to estimate loan losses. Management uses presently available information to estimate probable losses on loans; however, future additions to the allowance may be necessary based on changes in estimates, assumptions, or economic conditions. Significant factors that could give rise to changes in these estimates include, but are not limited to, changes in economic conditions in our local area, concentrations of risk and decline in local property values. The Company's determination as to the amount of its allowance for loan losses is subject to review by its regulatory agencies, which can require that we establish additional loss allowances. Refer to Note 4 of the Notes to Consolidated Financial Statements for more information on the allowance for loan losses. In management's opinion, the accounting policy relating to the valuation of investments is a critical accounting policy. We use a third party vendor to provide independent pricing of the securities in our investment portfolio, with the exception of four securities which are not actively traded. The third party vendor utilizes public quotations, third party dealer quotes and pricing models. For the four securities that are not actively trading, the Company utilizes discounted cash flow models to determine fair value pricing. Thus, the determination of fair value pricing on investments may require significant judgment or estimation, particularly when liquid markets do not exist for the item being valued. The use of different assumptions for these valuations could produce significantly different results which may have material positive or negative effects on the results of our operations. Refer to Note 8 of the Notes to Consolidated Financial Statements for more information on fair value. Management also considers the accounting policy relating to the impairment of investments to be a critical accounting policy due to the subjectivity and judgment involved and the material effect an impairment loss could have on the consolidated results of income. The credit portion of a decline in the fair market value of investments below cost deemed to be OTTI may be charged to earnings resulting in the establishment of a new 30 -------------------------------------------------------------------------------- cost basis for an asset. Management continually reviews the current value of its investments for evidence of OTTI. Refer to Note 3 of the Notes to Consolidated Financial Statements for more information on OTTI. These critical policies and their application are reviewed periodically by our Audit/Risk Committee and our Board of Directors. All accounting policies are important, and as such, we encourage the reader to review each of the policies included in the notes to our audited Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended
December 31, 2013to better understand how our financial performance is reported.
Analysis of Net Interest Income
Net interest income represents the difference between the interest we earn on our interest-earning assets, such as mortgage loans and investment securities, and the expense we pay on interest-bearing liabilities, such as deposits and borrowings. Net interest income depends on both the volume of our interest-earning assets and interest-bearing liabilities and the interest rates we earn or pay on them. Average Balances, Interest and Average Yields. The following table sets forth certain information relating to our average balance sheets and reflects the average yield on interest-earning assets and average cost of interest-bearing liabilities, interest earned and interest paid for the periods indicated. Such yields and costs are derived by dividing interest income or expense by the average balance of interest-earning assets or interest-bearing liabilities, respectively, for the periods indicated. Average balances are derived from daily balances over the periods indicated. The average balances for loans are net of allowance for loan losses, but include non-accrual loans. Interest income on securities does not include a tax equivalent adjustment for bank qualified municipals. For the Three Months Ended For the Three Months Ended March 31, 2014 March 31, 2013 Interest Interest Average Income/ Yield/ Average Income/ Yield/ Balance Expense Rate Balance Expense Rate (Dollars in thousands) Interest-earning assets: Interest-earning deposits & federal funds sold
$ 13,081 $ 10.03% $ 15,037 $ 30.08% Securities 159,113 1,232 3.10% 158,753 1,179 2.97% Loans 275,698 3,305 4.80% 272,079 3,479 5.11% Total interest-earning assets 447,892 4,538 4.05% 445,869 4,661 4.18% Other assets 34,758 33,841 Total assets $ 482,650 $ 479,710Interest-bearing liabilities Demand & NOW accounts $ 44,373 $ 130.12% $ 41,298 $ 120.12% Money market accounts 78,495 69 0.35% 70,146 65 0.37% Savings accounts 39,841 10 0.10% 37,232 10 0.11% Time deposits 192,282 665 1.38% 198,567 723 1.46% Borrowed funds 19,206 44 0.92% 24,890 76 1.22% Other interest-bearing liabilities 1,134 25 8.82% 1,193 26 8.72% Total interest-bearing liabilities 375,331 826 0.88% 373,326 912 0.98% Other non-interest bearing liabilities 40,516 39,046 Stockholders' equity 66,803 67,338 Total liabilities & stockholders' equity $ 482,650 $ 479,710Net interest income $ 3,712 $ 3,749Interest rate spread 3.17% 3.20% Net interest margin 3.32% 3.36% 31
Rate Volume Analysis. The following table analyzes the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. The table shows the amount of the change in interest income or expense caused by either changes in outstanding balances (volume) or changes in interest rates. The effect of a change in volume is measured by applying the average rate during the first period to the volume change between the two periods. The effect of changes in rate is measured by applying the change in rate between the two periods to the average volume during the first period. Changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately to the absolute value of the change due to volume and the change due to rate. Three Months Ended March 31, 2014 Compared to Three Months Ended March 31, 2013 Rate Volume Net Change (Dollars in thousands) Interest-earning assets: Interest-earning deposits & federal funds sold
$ (2)$ - $ (2)Securities 50 3 53 Loans, including fees (220) 46 (174) Total interest-earning assets (172) 49 (123) Interest-bearing liabilities: Demand & NOW accounts - 1 1 Money market accounts (3) 7 4 Savings accounts (1) 1 - Time deposits (36) (22) (58) Total deposits (40) (13) (53) Other interest-bearing liabilities: Borrowed funds & other (17) (16) (33) Total interest-bearing liabilities (57) (29) (86) Total change in net interest income $ (115) $ 78 $ (37)Our earnings may be adversely impacted by an increase in interest rates because the majority of our interest-earning assets are long-term, fixed rate mortgage-related assets that will not re-price as long-term interest rates increase. As rates rise, we expect loan applications to decrease, prepayment speeds to slow down and the interest rate on our loan portfolio to remain static. Conversely, a majority of our interest-bearing liabilities have much shorter contractual maturities and are expected to re-price, resulting in increased interest expense. A significant portion of our deposits have no contractual maturities and are likely to re-price quickly as short-term interest rates increase. Therefore, in an increasing rate environment, our cost of funds is expected to increase more rapidly than the yields earned on our loan and securities portfolios. An increasing rate environment is expected to cause a decrease in our net interest rate spread and a decrease in our earnings. In order to mitigate this effect, the Bank's Asset-Liability Committee is continuing to review its options in relation to core deposit growth, implementation of new products, promotion of adjustable rate commercial loan products and use of derivative products. In a decreasing interest rate environment, our earnings may increase or decrease. If long-term interest-earning assets do not re-price and interest rates on short-term deposits begin to decrease, earnings may rise. However, low interest rates on loan products may result in an increase in prepayments, as borrowers refinance their 32
loans. If we cannot re-invest the funds received from prepayments at a comparable spread, net interest income could be reduced. Also, in a falling interest rate environment, certain categories of deposits may reach a point where market forces prevent further reduction in interest paid on those products. The net effect of these circumstances is reduced net interest income and possibly net interest rate spread.
In the current environment, rates on the lending and investment portfolios have declined significantly, as have rates on deposit products and borrowed funds, which has assisted in keeping our interest rate spread at a moderate level. In the current extended low rate environment, the cost of funding is beginning to fall more slowly than the decline in asset yields, which has resulted in a decreasing net interest margin. For the three months ended
March 31, 2014, the average yields on our loan portfolio and investment portfolio were 4.80% and 3.10%, respectively, in comparison to 5.11% and 2.97%, respectively, for the three months ended March 31, 2013. Overall, the average yield on our interest earning assets decreased by 13 basis points to 4.05% for the three months ended March 31, 2014in comparison to the three months ended March 31, 2013, primarily due to lower interest income earned on our loan portfolio due to the low interest rate environment, partially offset by higher interest income earned on our investment portfolio due to purchases of longer term municipal bonds in 2013. For the three months ended March 31, 2014, the average interest rate that we were paying on interest-bearing liabilities decreased by 10 basis points to 0.88% in comparison to the same period in the prior year. This was partially due to a 30 basis point decrease in the average interest rate paid on our borrowings from 1.22% for the three months ended March 31, 2013to 0.92% for the three month period ended March 31, 2014and an 8 basis point decrease in the average interest rate paid on time deposits from 1.46% for the three month period ended March 31, 2013to 1.38% for the three month period ended March 31, 2014. Our interest rate spread for the three months ended March 31, 2014and 2013 was 3.17% and 3.20%, respectively. Our net interest margin was 3.32% and 3.36% for the three months ended March 31, 2014and 2013, respectively.
Comparison of Financial Condition at
Total assets at
March 31, 2014were $488.0 million, an increase of $5.8 million, or 1.2%, from $482.2 millionat December 31, 2013. The increase in total assets was primarily due to a $10.9 millionincrease in cash and cash equivalents, partially offset by a $2.6 milliondecrease in securities available for sale, a $1.9 milliondecrease in loans receivable, net and a $727,000decrease in other assets. Cash and cash equivalents increased by $10.9 million, or 63.4%, from $17.2 millionat December 31, 2013to $28.1 millionat March 31, 2014. The increase was primarily attributed to a $5.1 millionincrease in total deposits, the receipt of pay-downs on the investment and loan portfolios and cash proceeds from the sale of one security, partially offset by cash used to originate loans and paydown borrowings. Securities available for sale decreased by $2.6 million, or 1.7%, to $155.3 millionat March 31, 2014compared to $158.0 millionat December 31, 2013. The decrease was primarily due to the receipt of $3.5 millionin pay-downs on the investment portfolio and the sale of an asset-backed security for $1.5 millionduring the three month period ended March 31, 2014. There were no purchases of available for sale securities during the three month period ended March 31, 2014. The decrease was partially offset by a $2.5 millionincrease in the market value (before taxes) of the securities available for sale portfolio between December 31, 2013and March 31, 2014due to a decrease in market interest rates. 33
Net loans receivable decreased during the three month period ended
At March 31, At December 31, Change 2014 2013 $ % (Dollars in thousands) Real Estate Loans: Residential, one- to four-family
$ 169,172 $ 170,793 $ (1,621)(0.9) % Home equity 31,209 31,675 (466) (1.5) % Commercial 58,239 58,746 (507) (0.9) % Construction 1,401 936 465 49.7 % Total real estate loans 260,021 262,150 (2,129) (0.8) % Other Loans: Commercial 13,059 12,645 414 3.3 % Consumer 1,395 1,517 (122) (8.0) % Total gross loans 274,475 276,312 (1,837) (0.7) % Allowance for loan losses (1,780) (1,813) 33 1.8 % Net deferred loan costs 2,795 2,846 (51) (1.8) % Loans receivable, net $ 275,490 $ 277,345 $ (1,855)(0.7) % The decrease in net loans receivable was primarily due to a decrease in real estate loans, partially offset by an increase in commercial business loans. As one- to four-family residential real estate loans present additional interest rate risk to our loan portfolio, we remained strategically focused in 2014 on originating adjustable rate commercial real estate and commercial business loans to diversify our asset mix, to take advantage of the opportunities available to serve small businesses in our market area, and to maintain a strong net interest margin. Management continues to look for high quality loans to add to its portfolio and will continue to emphasize loan originations to the extent that it is profitable and prudent. Other assets decreased by $727,000, or 32.2%, to $1.5 millionas of March 31, 2014as compared to $2.3 millionat December 31, 2013. The decrease was primarily due to a decrease in deferred tax assets due to an adjustment in deferred taxes as a result of an increase in unrealized gains on the securities available for sale portfolio during the first three months of 2014.
The table below shows changes in deposit balances by type of deposit account between
At March 31, At December 31, Change 2014 2013 $ % (Dollars in thousands) Demand deposits and NOW accounts: Non-interest bearing
$ 35,251 $ 34,320 $ 9312.7 % Interest bearing 46,249 44,517 1,732 3.9 % Money market 78,579 77,990 589 0.8 % Savings 41,143 38,833 2,310 5.9 % Time deposits 192,115 192,575 (460) (0.2) % Total Deposits $ 393,337388,235 5,102 1.3 % 34
-------------------------------------------------------------------------------- The increase in total deposits was primarily due to an increase in all deposit categories except for time deposits. The growth in checking, savings, and money market accounts was the result of the Company's continued strategic focus on growing core deposits among its retail and commercial customers. Our borrowings, consisting of advances from the FHLBNY, decreased by
$550,000, or 2.8%, from $19.5 millionat December 31, 2013to $19.0 millionat March 31, 2014. Long-term debt decreased $800,000, or 10.2%, from $7.9 millionat December 31, 2013to $7.1 millionat March 31, 2014. Short-term borrowings increased $250,000, or 2.1%, from $11.7 millionat December 31, 2013to $11.9 millionat March 31, 2014. As long-term debt matured, the Company paid off $550,000of such debt in order to reduce interest expense, and the remaining proceeds were transferred into short-term borrowings to take advantage of lower interest rates. Total stockholders' equity increased by $2.1 million, or 3.3%, from $65.3 millionat December 31, 2013to $67.4 millionat March 31, 2014. The increase was primarily due to a $1.5 millionincrease in unrealized mark to market gains on available for sale securities (after taxes) and net income of $775,000during the three month period ended March 31, 2014, partially offset by $147,000in cash dividends paid during the three month period ended March 31, 2014.
Comparison of Results of Operations for the Three Months Ended
General. Net income was
$775,000for the three months ended March 31, 2014, or $0.14per diluted share, a decrease of $131,000, or 14.5%, compared to net income of $906,000, or $0.16per diluted share, for the three months ended March 31, 2013. The decrease in net income was primarily due to a $135,000increase in non-interest expense, a $37,000decrease in net interest income and a $35,000decrease in non-interest income, partially offset by a $45,000decrease in provision for loan losses and a $31,000decrease in income tax expense. Interest Income. Interest income decreased by $123,000, or 2.6%, to $4.5 millionfor the three months ended March 31, 2014compared to the three months ended March 31, 2013. Loan interest income decreased by $174,000, or 5.0%, to $3.3 millionfor the three months ended March 31, 2014compared to the three months ended March 31, 2013, due to a decrease in the average yield of the loan portfolio from 5.11% for the three months ended March 31, 2013to 4.80% for the three months ended March 31, 2014. The average yield on the loan portfolio decreased as new loans were originated or existing loans were refinanced at lower yields than the rates earned on loans which had paid off, as a result of the current low interest rate environment. The average balance of the loan portfolio increased $3.6 million, or 1.3%, from $272.1 millionfor the three months ended March 31, 2013to $275.7 millionfor the three months ended March 31, 2014. The increase in the average balance of loans receivable was primarily due to an increase in the average balance of one- to four-family real estate loans, commercial real estate loans and home equity loans, partially offset by a decrease in the average balance of commercial business loans. Investment interest income increased by $53,000, or 4.5%, to $1.2 millionfor the three months ended March 31, 2014compared to the three months ended March 31, 2013, due to an increase in the average yield on investments from 2.97% for the three months ended March 31, 2013to 3.10% for the three months ended March 31, 2014. The average yield on the investment portfolio increased due to the purchase of higher yielding investments during the second half of 2013. The average balance of the investment portfolio increased from $158.8 millionfor the three months ended March 31, 2013to $159.1 millionfor the three months ended March 31, 2014. Interest Expense. Interest expense decreased $86,000, or 9.4% for the three months ended March 31, 2014to $826,000compared to $912,000for the three months ended March 31, 2013. Interest expense on deposits decreased by $53,000, or 6.5%, to $757,000for the three months ended March 31, 2014when compared to the three months ended March 31, 2013primarily due to the decrease in the average rate paid on deposits and a shift in the deposit mix, resulting in a larger percentage of the deposit portfolio consisting of low cost core deposits. The average balance of deposits for the three months ended March 31, 2014was $355.0 millionwith an average rate of 0.85% compared to the average balance of deposits of $347.2 millionand an average rate of 0.93% for the three months ended March 31, 2013. The decrease in the average rate paid on deposits was due to the continued low interest rate environment during the first three months of 2014. The interest expense related to advances from the FHLBNY decreased $32,000, or 42.1%, to $44,000for the three months ended 35 -------------------------------------------------------------------------------- March 31, 2014when compared to the three months ended March 31, 2013. This decrease was due to a $5.7 milliondecrease in average FHLBNY advance balances and a 30 basis point decline in the average rate paid on FHLBNY advances when comparing the three months ended March 31, 2014with the three months ended March 31, 2013. The decrease in the average FHLBNY advance balances was a result of the Company's decision to utilize excess cash obtained from loan and security prepayments to pay down long-term borrowings. The low interest rate environment caused the average rate paid on borrowings to decrease. Provision for Loan Losses. A provision to the allowance for loan losses was not recorded during the three month period ended March 31, 2014, as compared to a provision of $45,000during the three month period ended March 31, 2013. Net charge-offs were $33,000for the three month period ended March 31, 2014compared to $17,000for the three month period ended March 31, 2013. Our non-performing loans increased to $5.3 million, or 1.91% of total loans, at March 31, 2014as compared to $2.5 million, or 0.93% of total loans, at March 31, 2013. The increase in the non-performing loans at March 31, 2014was primarily due to the addition of two non-performing commercial real estate loans with a total outstanding balance of $2.3 million. During the three months ended March 31, 2014, the Company recorded a $54,000provision for loan losses on one- to four-family loans and home equity loans as part of its review of certain environmental factors used to qualitatively assess inherent losses in the loan portfolio. Management concluded that an adjustment was necessary to account for the potential economic impact of recently announced company closings within the Chautauqua Countymarket area. An $11,000provision for loan losses was recorded on consumer loans as part of management's review of the historical losses relating to these types of loans. The Company determined an adjustment for loan losses was necessary due to an increase in historical average net charge-offs over the last three years. These provisions for loan losses were offset by a $71,000credit for loan losses on commercial real estate and commercial business loans during the three months ended March 31, 2014, primarily due to a review of the historical losses relating to these types of loans. The Company determined an adjustment for loan losses was necessary due to a decrease in historical average net charge-offs over the last four years. During the three months ended March 31, 2014, the Company recorded an unallocated provision for loan losses of $6,000. This unallocated provision reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating allocated and general losses in the portfolio. During the three month period ended March 31, 2013, the Company recorded a $145,000provision for loan losses on one- to four-family loans and consumer loans that had become classified loans or had been downgraded due to certain factors, such as delinquency or bankruptcy of the borrower. Upon review of the historical losses relating to commercial loans during the three month period ended March 31, 2013, the Company determined that a $37,000provision for loan losses was necessary due to an increase in average net charge-offs during the three year period ended December 31, 2012. Upon review of the environmental factors relating to commercial real estate loans during the three month period ended March 31, 2013, the Company determined that a $134,000credit for loan losses was necessary due to a decrease in average commercial real estate loan balances.
Refer to Note 4 of the Notes to the Consolidated Financial Statements for details on the methodology of the provision for loan losses.
Non-interest Income. Non-interest income decreased
$35,000, or 6.8%, to $480,000for the three months ended March 31, 2014compared to the three months ended March 31, 2013. The decrease was primarily due to a $98,000loss on the sale of one asset backed security during the three months ended March 31, 2014. This decrease was partially offset by an $83,000recovery on a previously impaired security. Earnings on bank owned life insurance decreased $17,000, or 21.2%, for the three months ended March 31, 2014when compared to the three months ended March 31, 2013, due to declining yields. Non-interest Expenses. Non-interest expenses increased $135,000, or 4.4%, from $3.1 millionfor the three months ended March 31, 2013to $3.2 millionfor the three months ended March 31, 2014. The increases were primarily due to increases in salaries and employee benefit expenses and occupancy and equipment expenses in first quarter of 2014. Salaries and employee benefits expense increased $101,000, or 6.5%, for the three months ended March 31, 2014compared to the three months ended March 31, 2013. The increase was 36 -------------------------------------------------------------------------------- primarily due to increased staffing for our newest branch office in Snyder, NY, which opened in April 2013and annual salary increases. Occupancy and equipment expense increased $67,000, or 13.6%, for the three months ended March 31, 2014compared to the three months ended March 31, 2013, primarily due to increases in software maintenance costs, utilities, property taxes, maintenance and repairs of buildings and equipment and the opening of the Snyderbranch office in the second quarter of 2013. Data processing expenses increased $26,000, or 16.6%, during the three months ended March 31, 2014primarily due to the costs associated with the implementation of new mobile banking, online banking and loan origination technology and related software as well as consulting fees related to the negotiation of our core processing contract. Other expenses decreased $31,000, or 9.9%, for the three months ended March 31, 2014compared to the three months ended March 31, 2013, primarily due to decreased expenses for foreclosed properties. Income Tax Expense. Income tax expense decreased by $31,000, or 14.8%, from $210,000for the three months ended March 31, 2013to $179,000for the three months ended March 31, 2014. The decrease was primarily due to the decrease in income during the three months ended March 31, 2014. The effective tax rate was 18.80% for the three months ended March 31, 2014and 2013. Loans Past Due and Non-performing Assets. We define non-performing loans as loans that are either non-accruing or accruing whose payments are 90 days or more past due and non-accruing troubled debt restructurings. Non-performing assets, including non-performing loans and foreclosed real estate, totaled $5.8 million, or 1.20% of total assets, at March 31, 2014and $5.2 million, or 1.08% of total assets, at December 31, 2013. 37
The following table presents information regarding our nonaccrual loans, accruing loans delinquent 90 days or more, foreclosed real estate and performing loans classified as troubled debt restructurings as of the dates indicated.
March 31, At December 31, 20142013 (Dollars in thousands)
Loans past due 90 days or more but still accruing: Real estate loans: Residential, one- to four-family
$ - $ 79 Home equity - 2 Commercial - - Construction - - Other loans: Commercial 15 - Consumer 9 - Total $ 24 $ 81 Loans accounted for on a non-accrual basis: Real estate loans: Residential, one- to four-family
$ 2,319$ 2,145 Home equity 301 325 Commercial 2,538 1,911 Construction - - Other loans: Commercial 77 137 Consumer 4 7 Total non-accrual loans 5,239 4,525 Total non-performing loans 5,263 4,606 Foreclosed real estate 577 581 Total non-performing assets $ 5,840$ 5,187 Ratios: Non-performing loans as a percent of net loans: 1.91 % 1.66 % Non-performing assets as a percent of total assets: 1.20 % 1.08 % Troubled debt restructuring: Loans accounted for on a non-accrual basis Residential, one- to four-family $ 44 $
Performing loans Residential, one- to four-family $ 143 $ 144 Home equity 4 4 38
The following table sets forth activity in our allowance for loan losses and other ratios at or for the dates indicated.
At or for the Three Months Ended March 31, 2014 2013 (Dollars in thousands) Balance at beginning of year: $ 1,813 $ 1,806 Provision for loan losses - 45 Charge-offs: Real estate loans: Residential, one- to four-family (17) - Home equity (13) - Commercial - - Construction - - Other loans: Commercial (4) (20) Consumer (7) (4) Total charge-offs (41) (24) Recoveries: Real estate loans: Residential, one- to four-family - - Home equity - - Commercial - 5 Construction - - Other loans: Commercial - 2 Consumer 8 - Total recoveries 8 7 Net charge-offs (33) (17) Balance at end of period $ 1,780 $ 1,834 Average loans outstanding
$ 275,698 $ 272,079Allowance for loan losses as a percent of total net loans 0.65%
Allowance for loan losses as a percent of non-performing loans 33.82%
Ratio of net charge-offs to average loans outstanding(1) 0.05% 0.02% (1) Annualized 39
Liquidity and Capital Resources
Liquidity describes our ability to meet the financial obligations that arise during the ordinary course of business. Liquidity is primarily needed to meet the lending and deposit withdrawal requirements of our customers and to fund current and planned expenditures. Our primary sources of funds consist of deposits, scheduled amortization and prepayments of loans and mortgage-backed and asset-backed securities, maturities and sales of other investments, interest earning deposits at other financial institutions and funds provided from operations. We have a written agreement with the Federal Home Loan Bank of
New York, which allows us to borrow up to $124.8 millionas of March 31, 2014, and is collateralized by a pledge of certain fixed-rate residential, one- to four-family real estate loans. At March 31, 2014, we had outstanding advances under this agreement of $19.0 million. We have a written agreement with the Federal Reserve Bankdiscount window for overnight borrowings which is collateralized by a pledge of our securities, and allows us to borrow up to the value of the securities pledged, which was equal to a book value of $10.6 millionand a fair value of $11.2 millionas of March 31, 2014. There were no balances outstanding with the Federal Reserve Bankat March 31, 2014. We also have established lines of credits with correspondent banks for $22.0 million, of which $20.0 millionis unsecured and the remaining $2.0 millionis required to be secured by a pledge of our securities when a draw is made. There were no borrowings on these lines as of March 31, 2014. Historically, loan repayments and maturing investment securities were a relatively predictable source of funds. However, in light of the current economic environment, there are now more risks related to loan repayments and the valuation and maturity of investment securities. In addition, deposit flows, calls of investment securities, and prepayments of loans and mortgage-backed securities are strongly influenced by interest rates, general and local economic conditions, and competition in the marketplace. These factors and the current economic environment reduce the predictability of the timing of these sources of funds. Our primary investing activities include the origination of loans and the purchase of investment securities. For the three months ended March 31, 2014, we originated loans of approximately $7.5 millionin comparison to approximately $9.8 millionof loans originated during the three months ended March 31, 2013. We did not purchase any investment securities in the three months ended March 31, 2014as compared to $10.7 millionof purchases in the three months ended March 31, 2013. At March 31, 2014, we had loan commitments to borrowers of approximately $6.2 millionand overdraft lines of protection and unused home equity lines of credit of approximately $29.0 million. Total deposits were $393.3 millionat March 31, 2014, as compared to $384.3 millionat March 31, 2013. Time deposit accounts scheduled to mature within one year were $79.1 millionat March 31, 2014. Based on our deposit retention experience, current pricing strategy, and competitive pricing policies, we anticipate that a significant portion of these time deposits will remain with us following their maturity. In recent years, macro-economic conditions negatively impacted liquidity and credit quality across the financial markets as the U.S. economy experienced an economic downturn. Although recent reports have indicated improvements in the macro-economic conditions, the economic downturn has had far-reaching effects. However, our financial condition, credit quality and liquidity position remain strong. We are committed to maintaining a strong liquidity position; therefore, we monitor our liquidity position on a daily basis. We anticipate that we will have sufficient funds to meet our current funding commitments. The marginal cost of new funding, however, whether from deposits or borrowings from the Federal Home Loan Bank, will be carefully considered as we monitor our liquidity needs. Therefore, in order to minimize our cost of funds, we may consider additional borrowings from the Federal Home Loan Bankin the future. We do not anticipate any material capital expenditures during the remainder of 2014. We do not have any balloon or other payments due on any long-term obligations or any off-balance sheet items other than loan commitments as described in Note 6 in the Notes to our Consolidated Financial Statements and the borrowing agreements noted above. 40 --------------------------------------------------------------------------------
Off-Balance Sheet Arrangements
Other than loan commitments, we do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources that is material to investors. Refer to Note 6 in the Notes to our Consolidated Financial Statements for a summary of commitments outstanding as of
March 31, 2014.